the tablet war: dispatches from the front lines

In the past week or so, there have been two significant developments in the story of the development of the PC tablet:

–one is the outpouring of reports, both from the blogosphere and in newspapers, that the iPad is cannibalizing the notebook.

–the other is that AAPL has made up with ADBE, sort of.

details

the iPad

The many blogger stories about cannibalization seem to have been generated as the result of a well-marketed brokerage research reports by analysts covering AAPL at UBS and Barclays Capital.  The Financial Times recently had a more comprehensive comment in its Lex column.

Clearly, something is happening.  But I’m not sure the cannibalization numbers add up or that the overall story makes any sense.

We know from INTC that the back to school season has been weaker than had been expected as late as early July.  Last minute processor order cancellations/deferrals were big enough for INTC to make a downward revision to revenues on August 27th, pointing to “weaker than expected demand for consumer PCs in mature markets.”  This quantified the weakness that Taiwanese IT firms and US laptop makers like DELL had been talking about in the prior weeks.

In its press release, INTC revises its September quarter sales down by about $600 million, or 5%.  If we assume 5% is a good proxy for the unit demand shortfall (since the sectors showing weakness are less expensive computers, the 5% probably understates the unit decline), then the reduction in units to be sold in the Us and Europe (mature markets) is about 5 million.  That figure probably exceeds AAPL’s production, and worldwide sales, of the iPad during July-September.

Also, the laptop sales shortfall is reported to be predominantly in the netbook end of the market.  I suspect this is because low-end “regular” laptops have come down in price and now mimicked the features of netbooks.  As a result, for several quarters the latter’s unit sales have been flattish in a rising market.  Besides, I can’t imagine anyone who has used a netbook or an iPad would think they were close substitutes for one another.  You might just as easily argue that smartphones are cannibalizing PCs.

F or what it’s worth, my guess is that the slowdown in consumer PC sales in the US and Europe is a slowdown-in-the-economy phenomenon, not a cannibalization one.

Nevertheless, there is extremely high interest in tablets, even though most of those intending to buy one don’t really know what they are or where they fit in among their digital devices.  According to a Forrester blog post from last Friday 2.5 million US online consumers already own an iPad and 7.4 million more intend to buy one.  An additional 20 million say they’re going to buy a tablet of some sort–not necessarily an iPad–over the next 12 months.  (This 27 million total surpasses the number of Americans intending to buy an e-reader, the next most desired device, by about a third).

The one characteristic of tablets that should jump out for investors is that none will have INTC microprocessors and most will likely have linux-based software, not MSFT’s.

This explosion of interest, and the resulting scramble by AAPL to increase production capacity and by other manufacturers to get their tablet devices into the market, may explain the apparent urgency behind INTC’s moves to acquire McAfee and Infineon’s cellphone chip business.

AAPL and ADBE

Last Thursday, AAPL posted a release on its website about “App Store Review Guidelines.”   It seems innocuous…but it isn’t.  Back when the iPad was being introduced, AAPL said the device wouldn’t support Adobe Flash.  Why?  Steve Jobs eventually wrote his thoughts in an open letter.  Although AAPL and ADBE have a long relationship, he wrote, but Flash is unreliable, poor performing, and not secure.  The world has passed ADBE by, as well.  Ouch!

Two other problems.  Flash is designed for PCs and uses a lot of processing power and battery life.  Also, if you could download Flash onto your iPad you could use services like Hulu and bypass the AAPL apps store.

AAPL went a step further, too.  ADBE had developed a cross-platform compiler, that is, a software program that’s something like a translation device.  It converts a Flash-created app into one in a programming language that AAPL found acceptable.  But AAPL said developers couldn’t use the ADBE compiler, either.  The result was that many app developers had to hire two staffs, one to develop specifically for AAPL, another to develop for the rest of the world.

Last week’s press release is AAPL’s capitulation on app development.  AAPL still won’t allow any Flash code to be downloaded into the iPad, but it will accept programs that have been cross compiled from Flash in to an Apple-approved language.

Why did AAPL give in?  Some people say it was ADBE’s appeal to the government anti-trust authorities.  Maybe.  But I think the real issue is the stunningly fast development of the tablet market.  After all, the iPad is a limited device.  It’s been crafted to avoid any cannibalization of the iPhone (remember–if we look at profits, AAPL is a cellphone maker with a couple of lucrative sidelines, like MP3 players and computers).  Users are funneled to its app store to get  content to use.  If AAPL could get developers to write code that would be very expensive to adapt for most other tablet devices, its first-to-market advantage would be that much more overwhelming.

It’s this last thing that the bland note linked above is raising the white flag to.  To me, it’s a signal that AAPL sees competition coming for the iPad faster than it had thought.  This isn’t 100% bad for the company.  Its dominance of the tablet market will likely be less complete, but the market will likely be very much larger than it had dreamed.  It wasn’t that long ago (March or April) that analysts laughed at AAPL for arranging for production capacity of 1 million units a month.  It’s now churning out twice that and still scrambling to expand fast enough to keep up with demand.

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